Shenzhen, China — The land of Nike shoes and plastic Christmas trees – and 40 percent of China’s factories – has been battered by falling foreign demand. But that doesn’t mean Guangdong Province is sitting idle. A pioneer in China’s capitalist experiments, it’s using the country’s worst slowdown in seven years to push ahead with a complete economic makeover.

Like Japan and the Asian tigers before it, China is moving to loosen the grip of high-volume, low-end manufacturing on its economy – and transform itself into a corner-office innovator that can dream up an idea and build it to exacting specifications.

Instead of just assembling iPods, in other words, China wants to invent the next “it” music player.In an unusual silver lining, the economic crisis may be helping: By shaking out low-profit companies, it’s making room for more advanced ones.

Last month, the National Development and Reform Commission announced revised plans to transform Guangdong and neighboring Hong Kong and Macau into a “significant innovation center” by 2020.

One hundred R&D labs will be set up over the next three years. By 2012, per-capita output in the region should jump 50 percent from 2007, to 80,000 yuan ($11,700) And by 2020, the study predicts, 30 percent of all industrial output should come from high-tech manufacturing.

“While some traditional competitive industries such as household appliances, textiles and garments, papermaking, and Chinese herbal medicine will be upgraded to increase competence, inefficient energy-consuming sectors will gradually be phased out,” the plan states.

Low-end factories will have to relocate to cheaper provinces or countries.

For provincial officials, whose standing rises with Guangdong’s economic performance, that’s the only way forward. As global recession hit Chinese exports last year, growth in this region dropped to 10.1 percent, from 14.7 percent in 2007.

“Restarting outdated capacities for the sake of growth would just be like drinking poison to quench thirst,” Guangdong’s Communist Party boss Wang Yang, an advocate of upgrading, wrote in a recent opinion piece.

Still, the economic crisis has forced some compromise. To stem the troubling tide of millions of layoffs, officials decided to prop up the struggling companies they’ve sought to run into the ground, by reinstating an export tax rebate to help them cut costs.

“They’re trying to provide enough benefits to companies so they don’t go out of business, while at the same time not backtracking too much,” says Arthur Kroeber, head of Dragonomics, a consultancy based in Beijing.

Stimulus measures aim to balance spurring the economy with not sacrificing hi-tech upgrading. The elimination last month of the value-added tax for capital equipment is a case in point, says Mr. Kroeber.

Greener autos

Another example is an auto-industry aid package that halves sales tax on certain cars and subsidizes owners of high-emission vehicles who exchange them for more fuel-efficient, cleaner ones. It also includes a 10 billion yuan ($1.5 billion) fund to promote new technology, including the mass production of electric vehicles.

The Chinese government has deep pockets to help push manufacturing up the value chain, says the Commerce Ministry’s Mr. Mei – tapping an array of perks from subsidized infrastructure, tax breaks, investment, and generous government contracts.

It also enjoyed liberal policies on resident permits for workers who had the right skills.

From Beijing’s perspective, the returns are worth the investment. The auto stimulus will benefit companies like BYD (“Build Your Dream”), a battery manufacturer-turned-carmaker that has advanced China’s green-car prospects and won it prestige as a globally recognized brand.

Already the world’s No. 2 batterymaker, it’s now the first company to have mass-produced hybrid, plug-in vehicles; it has also made an electric car.

“BYD is a key player in the world market,” says Duan Chengwu, an auto industry analyst with Global Insight, based in Shanghai.

The company’s international profile soared even higher last September when Warren Buffett bought a 10 percent stake in the company. At the Detroit Auto Show in January, BYD models got space on the main show floor – until then, Chinese carmakers had always been relegated to a basement or foyer.

Needed: workforce upgrade

In addition to putting massive resources into developing the infrastructure of high-tech upgrades, China needs to upgrade its workforce, says Liu Kaiming, head of the Shenzhen-based Institute for Contemporary Observation.

A lavish science park in Dongguan, a nearby factory city, illustrates the mismatch. The expansive campus – complete with apartments, hospital, school, mall, KFC, and a Hyatt hotel, all built around a natural lake and dotted with saplings and flower beds – is meant to impress.

But actually upgrading the “software” of manufacturing takes time. While some A-list companies like Huawei are setting up shop, many of the buildings remain uninhabited.

There are many “empty cages” these days, especially due to the economic crisis, says Mr. Liu. “But they are still waiting for the birds to come.”